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At the beginning of the year, I wrote two articles about the so-called "dog" strategy: "Dogging the Dow" and "Dogging the S&P 500." The point of the articles was to examine the dog strategy (investing in those companies having the highest dividend yield at the beginning of the year and holding those investments for the entire year) to see if that strategy performed any better than one that focused on the fundamentals of the companies within the same target group. I outlined those fundamentals in the articles, but they appear in a more current form in my Instablog "PIC: Potential Investment Criteria."

I have been posting weekly updates on the progress of two "competitions." From the Dow Jones Industrials I am pitting the "Dogs of the Dow" against a set of companies satisfying my set of criteria (the companies are called the "Pedigrees of the Dow). From the S&P 500 there are the "Dogs of the S&P" and my set of "Pedigrees of the S&P." I thought that since we are now at the end of the first quarter for 2013, a general review of the state of the comparisons would be interesting, as there are some interesting figures to note.

Dogging the Dow

The "Dogs of the Dow" strategy has been recognized since its introduction in 1972. In the past 40 years, the Dogs have averaged an annual yield of more than 14%, compared to an 11% annual yield for the Dow Jones Industrial Average as a whole. My goal was to construct a competing set of companies selected by the PIC strategy and compare the performance of the Dogs and (what I have called) the Pedigrees.

As luck would have it, five of the Dogs also qualified as Pedigrees, so my expectation was that there would not be a substantial difference between the two "teams." This year's Dogs are:

  1. DuPont (E.I.) De Nemours (NYSE:DD)
  2. General Electric Company (NYSE:GE)
  3. Hewlett-Packard Co. (NYSE:HPQ)
  4. Intel Corporation (NASDAQ:INTC)
  5. Johnson & Johnson (NYSE:JNJ)
  6. McDonald's Corporation (NYSE:MCD)
  7. Merck & Co. (NYSE:MRK)
  8. Pfizer Inc. (NYSE:PFE)
  9. AT&T Inc. (NYSE:T)
  10. Verizon Communications (NYSE:VZ)

Intel, Johnson & Johnson, McDonald's, Merck and Pfizer also qualified as Pedigrees, along with the following companies:

  1. Cisco Systems, Inc. (NASDAQ:CSCO)
  2. Chevron Corp. (NYSE:CVX)
  3. International Business Machines (NYSE:IBM)
  4. 3M Company (NYSE:MMM)
  5. Microsoft Corp (NASDAQ:MSFT)

The following chart sums up the performance of the two teams fairly well:


(Click to enlarge)

[NOTE: when discussing yields for the performance of the Dogs vs. the Dow, it is customary to exclude dividend payments from the results. A few readers have suggested - and I agree - that if dividend yield determines the selection of companies then it seems reasonable to include dividends in the results. In deference to those readers, I differentiate between "share yield" and "total yield," where total yield includes dividend payments, and will be limited to comparing the two trial groups, and where share yields, which do not include dividends, will be used whenever comparing the Dogs and Pedigrees to the Dow or any other instrument.]

Clearly, there is a substantial difference in the performance of the two teams, with the Dogs decisively dominating the Pedigrees by 625 BPS - no small difference, there. Moreover, this is despite the fact that half of the Pedigree team is comprised of members of the Dogs. For a detailed breakdown, let us examine the following table:


(Click to enlarge)

Looking over the two sets of figures, there is one thing that should stick out like a sore thumb: Hewlett-Packard has realized a share growth of 67.30% through Q1. Other than that, there is virtually no difference between the two sets of companies, as one ought to expect. Indeed, if we were to factor HP out of the competition, the remaining Dogs would have a share yield of 11.12% and a total yield of 12.15% - still outperforming the Pedigrees, but by a margin more consistent with the composition of the two teams.

The HP numbers have been (so far) consistent enough to indicate that the company is turning itself around - a largely reconstructed board of directors, a new CEO (Margaret Whitman), and the release of new tablet computers that have received a warm welcome from many reviewers. This is no small accomplishment, considering the difficulties that have plagued HP for many years (discussed in my recent article "Hewlett-Packard Company: Breaking Up Is Hard To Do").

Before turning to the S&P competition, we should look at how the two teams compare to the Dow itself. I also include the SPDR Dow Jones Industrial Average ETF Trust (NYSEARCA:DIA).


(Click to enlarge)

Here we are comparing share performance only, and not including dividend payments. Both the Dogs and the Pedigrees outperform the Dow and DIA. What I found interesting is the degree to which DIA mirrors the performance of the Dow - DIA is currently 11 BPS below the Dow, at 8.40% to the Dow's 8.51%; Excel's resolution is not adequate to differentiate the two readings unless the graph is sized about 5 times the size presented here. I doubt the editors would have been happy with me had I tried to publish a graph that large.

Dogging the S&P 500

The Standard & Poor 500 presents a substantially different challenge than the Dow. The Dow contains only 30 companies, the S&P has 500; the Dogs-of-the-Dow strategy has a 40-year history behind it, while there is no "official" "Dogs of the S&P 500" strategy (the strategy as used in my experiment was suggested by StockMarketPundits in the article "Dogs of the S&P 500"). A reader of my original "Dogging" article asked if such a comparison of the strategies within the S&P would be possible, so I set it up.

There is no overlap between the Dog group and the Pedigree group, but this is to be expected. The 30 companies in the Dow are selected carefully for their quality; this is not to say that the 500 companies in the S&P are not carefully selected, but are selected by different criteria, as the index is aimed at providing a broader representation of U.S. businesses. Given the difference between the two indexes, it would be surprising if there had been more than one or two companies overlapping. It is actually more surprising (to me, at least) that there were not more overlaps between the Dow groups.

The companies of the Dogs of the S&P 500 (the ten companies with the highest dividend yields) are:

  1. Cliffs Natural Resources Inc. (NYSE:CLF)
  2. CenturyLink, Inc. (NYSE:CTL)
  3. Excelon Corporation (NYSE:EXC)
  4. Frontier Communications Corp. (NASDAQ:FTR)
  5. Altria Group Inc. (NYSE:MO)
  6. Pitney Bowes Inc. (NYSE:PBI)
  7. Pepco Holdings, Inc. (NYSE:POM)
  8. Reynolds American Inc. (NYSE:RAI)
  9. R.R. Donnelley & Sons Co. (NASDAQ:RRD)
  10. Windstream Corporation (NASDAQ:WIN)

The companies of the Pedigrees of the S&P 500 (as determined by the PIC strategy) are:

  1. Analog Devices Inc. (NASDAQ:ADI)
  2. Baxter International Inc. (NYSE:BAX)
  3. Cisco Systems, Inc.
  4. Johnson & Johnson
  5. KLA-Tecor Corporation (NASDAQ:KLAC)
  6. Eli Lilly & Co. (NYSE:LLY)
  7. Mattel Inc. (NASDAQ:MAT)
  8. Pfizer Inc.
  9. Seagate Technology PLC (NASDAQ:STX)
  10. Texas Instruments Inc. (NASDAQ:TXN)

[The same NOTE applies to the S&P as it applied to the Dow - I use total yield (including dividends) when comparing the two groups, and share yield (excluding dividends) when comparing the groups to other instruments.] Cisco, Johnson & Johnson and Pfizer appear in the S&P comparison, just as they did in the Dow.


(Click to enlarge)

This time the Pedigrees have the upper hand over the Dogs, and by a substantial margin of 811 BPS. In this case, however, we do not have an overlap to make things interesting; but interesting they are, when we look at the corresponding table:


(Click to enlarge)

One reason for the Pedigrees' dominance is that six of the companies have total yields over 15%: Texas Instruments (15.54%), Pfizer (16.03%), Lilly (16.14%), Johnson & Johnson (17.18%), Seagate (20.18%), and Mattel (20.51%) (all including dividends paid out during Q1). On the other hand, while the Dogs have three companies with noteworthy yields - Pitney Bowes (43.19%), R.R. Donnelley (36.93%) and Excelon (17.70%) - they also have four companies with negative yield, most notably Cliffs Natural Resources, with a discouraging -50.32% yield.

Accounting for the extremes on this spectrum is perplexing. Cliffs, which is involved with mining iron ore and metallurgical coal, has had to cut back its operations because of a lack of demand; whether that accounts for the entire drawback is another thing. The yield realized by Pitney Bowes is somewhat surprising considering that its principal customer - the U.S. Postal Service - is on the ropes. Even more surprising, perhaps, is that it is apparently succeeding in the digital/internet marketplace where it offers services comparable to R.R. Donnelly, which is also seeing a growth spurt.

Before moving on, we can compare first-quarter share yields for the two groups of companies with the S&P 500 and S&P Depository Receipts (NYSEARCA:SPY):


(Click to enlarge)

As was the case with the Dow above, this graph shows the measure for the index and its associated ETF as being indistinguishable, and this time it's not just a matter of resolution - the S&P's yield this quarter is an even 7.00%, and the yield for SPY is 6.99%. Unfortunately, the Dog strategy trails the S&P by 264 BPS, while the PIC strategy leads the S&P by 674 BPS.

Remarks

It is still early in the game; there are three more quarters to put behind us before we can say anything conclusive about either the Dog strategy or the PIC strategy. In "Dogging the Dow" I suggested that one reason for the Dog's success was that, by picking companies with high dividend yields, Dogs may tend to be companies that were temporarily on a downturn and due for a resurgence - the resurgence being a bit more vibrant than the general market trend. That could certainly be true in the case of the Dow (consider HP's performance), but that approach in the S&P is not seeing the same results.

Cliffs is trading at approximately 20% of its value from two years ago, and approximately 27% of its value from this time last year, and while this might be attributed largely to a weak iron market, it is not the case for the other companies among the losing Dogs of the S&P. CenturyLink, Frontier and Windstream are all experiencing prolonged downturns, and all three are in an industry increasingly dominated by AT&T and Verizon. The outlook for these companies is not the brightest, and simply focusing on dividend yield does not give one an indication that there may be some major, persistent underlying cause for their downturns.

In short, outside of the rarefied atmosphere of the Dow Jones Industrials, the Dog strategy may turn out to be as prone to lose money as make it. A look at the fundamentals provides significantly more insight into a company than the company's dividend yield, something that may be substantially predetermined by membership in the Dow, but insufficiently established by membership in the S&P 500.

The weekly updates will continue - I will continue to post the updates on my Instablog.

Data (particularly updates) are drawn from Yahoo! Finance. This article is not intended as a recommendation of either the strategies discussed herein, or the companies mentioned. Please use due diligence before investing.

Source: Dogging The Dow And S&P 500: A First-Quarter Review